If a key element of the proposed U.S. system is to “encourage comparable action by other nations that are major trading partners and key contributors to global emissions,” should the design concepts in the NCEP plan (i.e., to take some action and then make further steps contingent on a review of what these other nations do) be part of a mandatory market-based program? If so, how?

It is important to distinguish between two distinct but related policy objectives: 1) achieving adequate action by all major emitting countries, and 2) protecting U.S. firms against competitiveness impacts. Each requires a different set of policy approaches.

Ensuring that other countries act against climate change is important from a competitiveness standpoint. However, it is first and foremost an environmental imperative: without adequate action by all major emitters, the goal of climate protection cannot be met. Of steps the United States can take to encourage other nations to act, establishing a mandatory program to limit and reduce U.S. emissions may in and of itself be the most critical. Lack of action by the United States stands as the major impediment to stronger efforts by other countries. Demonstrating the will – and establishing the means – to reduce U.S. emissions will greatly alter the international political dynamic and improve prospects for international cooperation.

Making future U.S. action expressly contingent on the efforts of other countries may provide some further inducement for action. Alternatively, by appearing irresolute, it may deter others from commencing ambitious long-term efforts. A more effective means of achieving adequate and comparable effort by all major emitters would be the establishment of mutual commitments through multilateral negotiation and agreements.60; In the case of developing countries, this should include or be complemented by positive incentives, preferably through market mechanisms.

Ensuring that efforts are broadly comparable, however, will not necessarily achieve the second objective: protecting against competitiveness impacts. It is not the competitiveness of the U.S. economy as a whole that is at issue. Competitiveness at the national scale is largely a reflection of productivity, and the U.S. economy consistently ranks among the world’s most competitive [1]. The cost of achieving mandatory GHG limits at the levels under consideration would only marginally affect projected economic growth and is unlikely to affect overall competitiveness [2].

To the degree there are competitiveness impacts, they would fall on specific sectors – energy-intensive industries whose goods are traded internationally, a relatively small segment of the U.S. economy [3]. However, these sectors could remain vulnerable even if efforts by all major emitters are broadly comparable because countries will choose to allocate effort differently [4]. For instance, a country may reduce overall emissions but exempt a given sector from controls, giving that sector an advantage over foreign competitors that are subject to controls. In that case, a review of comparability, unless undertaken sector by sector, offers little assurance against competitiveness impacts.

A full assessment of policy options for addressing competitiveness would require a more thorough analysis of the potential impacts on vulnerable sectors than is presently available. Generally, the impacts on a given sector or firm would depend on its specific competitive positioning and its ability to substitute and innovate. Most analyses of U.S. industry experience with past environmental regulation find little evidence of competitive harm. One comprehensive review – synthesizing dozens of studies across a range of U.S. regulations and sectors – concluded that while environmental standards may impose significant costs on regulated industries, they do not appreciably affect patterns of trade [5]. Some economic literature suggests that, to the contrary, innovation spurred by regulation may in fact confer a competitive advantage [6].

In the design of a cap-and-trade system, the best way to protect broadly against competitiveness impacts is to set the caps at modest levels and minimize compliance costs by, for instance, allowing offsets and full banking of allowances. The choice of allocation approach also has implications. A free “grandfathering” of allowances based on historic emissions provides inherent protection for potentially vulnerable firms by conferring assets whose sale can offset losses.

One option to mitigate potential competitiveness impacts is to provide supplemental allowances to sectors deemed to be vulnerable. Another is to dedicate funds — possibly by auctioning a portion of allowances — to assist vulnerable sectors. Assistance could include:

Incentives for the deployment of cleaner or more efficient technologies, such as accelerated depreciation of existing stock, or tax credits for the deployment of specific technologies or the production of less emissions-intensive products.

Further steps to address competitiveness would require some mechanism to identify vulnerable sectors based on an analysis of export patterns among energy-intensive industries and relative energy pricing in competing countries.

[3] Repetto et al. found in a 1997 analysis that, among all U.S. industries producing tradeable goods and services, roughly 90 percent of output and employment was in industries with energy costs representing 3 percent or less of output value. (Repetto, R., C. Maurer and G.C. Bird. “U.S. Competitiveness is Not at Risk in the Climate Negotiations.” WRI Issue Brief, October 1997.)

[4] The Carbon Trust recently suggested that differences between National Allocation Plans within the EU Emissions Trading system has significant implications on sectoral competitiveness even though country efforts under the overall system are widely viewed as compatible (Carbon Trust, “The European Emissions Trading Scheme: Implications for Industrial Competitiveness.” June, 2004. See also IISD, “Climate Change and Competitiveness: A Survey of the Issues,” March 2005; and European Commission, “International Trade and Competitiveness Effects,” Emissions Trading Policy Brief No. 6, 2003.)

[5] Jaffe, A.B., S.R. Peterson,P.R. Portney, and R.N. Stavins. “Environmental Regulation and the Competitiveness of U.S. Manufacturing: What Does the Evidence Tell Us?” Journal of Economic Literature. Vol. XXXIII, March 1995.